Abstract
This study aims to investigate the extent to which the conditional volatilities of both Shari’ah compliant stock and conventional stock are related to those of interest rate and exchange rate in the emerging economy of Pakistan. We used KMI 30 and KSE 100 indices for Islamic and conventional stock for the period of July 2008 to November 2013. We employed Generalized Autoregressive Conditional Heteroskedastic in the mean (GARCH-M) model. This framework relaxes constancy assumption of classical linear regression (CLRM) model and allows exchange rate and interest rate volatility to evolve over time. The GARCH-M framework also reveals results about risk-return trade-off in the context of both Islamic and conventional stock indices. The findings show positive and statistically significant effect of interest rate volatility on KSE-100, whereas KMI-30 remains unaffected by the same. Exchange rate volatility is found to be significant for both conventional and Islamic indices. The relationship of risk coefficient (γ) and stocks returns, as expected, is positive and statistically significant for both KMI-30 and KSE-100. This result is consistent with the theory of risk-return trade-off. The results of parametric t-test show significant difference between returns of both indices. This implies that Shari’ah compliant stock index (KMI-30) of Pakistan underperforms its conventional counterpart. By using different performance measures (Sharp ratio, Jensen alpha, Treynor ratio), this study also investigates the hypothesis that Islamic stock index has inferior performance compared with unscreened conventional counterparts due to availability of a smaller investment universe, increased monitoring costs, and limited diversification.
Highlights
This study aims to investigate the extent to which the conditional volatilities of both Shari’ah compliant stock and conventional stock are related to those of interest rate and exchange rate in the emerging economy of Pakistan
The test of normality clearly shows that both return series are not normally distributed and null hypothesis of normality of data is rejected at 1 % significance level by employing Jarque-Bera (JB) test statistics
Prime arguments given by the opponents of ethical investing include restricted diversification, availability of smaller investment universe, and additional screening and monitoring cots are
Summary
This study aims to investigate the extent to which the conditional volatilities of both Shari’ah compliant stock and conventional stock are related to those of interest rate and exchange rate in the emerging economy of Pakistan. The Shari’ah screenings criteria applied by the Islamic scholars have enabled Shari’ah Complaint Stock Indices to distinguish themselves from conventional stocks indices. There are two Shari’ah screening criteria – positive and negative. Positive screenings allow an Islamic index to include those companies that meet certain Islamic ethical indicators (both quantitative and qualitative) whilst negative screenings delete stocks which are unable to meet such requirements. The common stock guidelines, Rana and Akhter Financial Innovation (2015) 1:15 accepted by Shari’ah scholars, have become a key factor in the growth of Islamic funds all over the world. Majority of the Shari’ah scholars are agreed that buying and selling of stocks &shares adhere to Shari’ah laws because shares & stocks represent real assets. Equities, mutual funds, and government bonds are considered more compatible with Shari’ah screenings criteria of profit and risk sharing than fixed income assets
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